Strong Apple Earnings May Not Stop Microsoft Market Increase

Apple reported strong earnings for the last fiscal quarter, including sales of over 3.05 million Macs. But while Apple dominates many markets, including digital media and smartphones, and has increased its PC market share, it may not be able to prevent a slowdown or even erosion in market share once Windows 7 is released on Oct. 22.

Apple
posted strong numbers during its earnings call on Oct. 19, representing welcome
news for an industry otherwise beaten down by a long-running economic
recession.
Despite Apple's tradition of conservative reporting, which led it to post
summer estimates of $8.7 billion to $8.9 billion for the fourth fiscal quarter
of 2009, the company ended up reporting revenue of $9.87 billion and a quarterly
profit of $1.67 billion. Strong
sales of the iPhone 3GS, which sold over a million units in the three days
following its June release, helped buoy that bottom line.

Those sales numbers included about 3.05 million Macs, a 17 percent
year-over-year quarterly rise from 2008. In an Oct. 19 earnings call, Apple
Chief Operating Officer Tim Cook said sales had exceeded the company's internal
targets and the rise in sales of laptops was 35 percent year over year.

Even with such robust figures, though, Apple could potentially find itself
challenged by the Oct. 22 release of Windows 7, which could potentially spark a
massive
tech refresh through 2010 and help Microsoft reverse a trend of declining
revenues.
More to the point, Windows 7 may slow Apple's recent gains in the PC market,
or even cause a modest correction in sales numbers. Whether that will happen is
partially dependent on whether Apple's gains have truly come as a result of
people fleeing the Windows ecosystem due to Windows Vista, which, despite
corrective service packs issued since its 2007 release, has maintained a
reputation as bloated and unreliable.
"Over the past three years, I can't think of a product-except maybe
Windows Me-that has damaged Microsoft in the way that Vista has; since Vista's
launch, Microsoft's reputation has really taken a major hit," Charles
King, an analyst with Pund-IT Research, said in an interview with eWEEK.
"During that same time, I can't think of a time when Apple hasn't been, to
a greater degree, ascendant."
That period saw Apple come to dominate the digital media market through its
iPod ecosystem, which includes the iTunes online store. It has also muscled its
way into the smartphone market with the iPhone, currently a favorite of
consumers. However, Apple has only managed to gain a few more points of PC
market share, reaching about 10 percent. "Apple was the cat's meow of the
PC industry," King said, "and all they could do was gain three
points. Losing or gaining three points is not a big deal in the PC space."
Some analysts see the Windows 7 release as potentially leading to a slight increase
in Apple sales, at least in the short term.
"Windows 7 will likely do some damage, but it could also raise store
volume enough to drive an uptick across the board, including Apple," Rob
Enderle, an analyst with the Enderle Group, said in an e-mail to eWEEK. With
regard to the current quarter, "I was expecting Macs [sales] to be strong
because the PC was hamstrung due to the October Windows 7 launch," he
said.
"The Windows 7 stuff is going to put massive pressure on their
margins," Enderle added. In that light, Apple's claims during the earnings
call of lower gross margins for the next quarter seem logical: "It makes
sense that they want to lower expectations a lot, otherwise they'll likely
miss."
Part of the reason for Apple's inability to seize a more substantial
proportion of the PC market might trace back to the late 1990s, when returning CEO
Steve Jobs made the decision to kill the Mac clone business. According to
Leander Kahney's book "Inside Steve's Brain," that decision was
controversial but proved beneficial from a brand-consolidation perspective.
"It instantly allowed Apple to capture the whole Mac market again by
eliminating the competition," Kahney wrote. "Customers could no
longer get a cheaper Mac from Power Computing or Motorola or Umax. The only
competition was Windows, and Apple was a different proposition."
The Mac clone market had not proven particularly successful, anyway, with
sales staying relatively flat and Apple itself reporting a $69 million loss and
1,300 layoffs for the first quarter of 1996.
With Apple in a stronger position 12 years later, though, the decision to
not clone out its operating system-even in a tightly controlled, very limited
way-could have denied the company a few points of market share while Microsoft
reeled from the initial effects of the reaction to Vista.
"Jobs' decision to kill the clone market for the Mac and stake
everything [on what was] under the company's own roof is hard to justify from a
market volume or market-share standpoint," King said. "It's been
great for profitability, and they make terrific products, but if your goal is
to get out into the market, then Apple denied itself a mechanism [with which]
to make that happen."
Nonetheless, analysts' predictions ahead of Apple's earnings call had the
company posting robust numbers, although the potential for clouds on the
horizon exist.
Many of Apple's strongest areas are associated with the mobile device
market. The iPhone is now available in over 80 countries; cumulative shipments
since June 2007 have reached 26.4 million units. On top of that, "Apple
continues to gain share across its major product lines (MacBook notebooks, Mac
desktops, iPod digital music players, iPhone smartphone and the iTunes
application)," Brian Marshall, an analyst with Broadpoint AmTech, wrote in
an Oct. 12 research note. "Its business model is becoming stronger over
time as well with continued penetration of international markets."
On top of that, Apple's net cash hoard stands at roughly $31.1 billion,
eclipsing the reserves held by Cisco Systems ($25 billion), Microsoft ($24
billion) or Google ($19 billion). Moreover, Apple has traditionally shied away
from acquisitions, making it more likely to hold onto the bulk of this cash
reserve in the short term.
However, Marshall suggested,
there are also downward pressures exerting themselves on Apple. Specifically,
Apple's gross margins peaked at around 36.9 percent in June 2007 and have
declined since, to 34.7 percent at the end of 2008.
"This trend should continue as pricing pressure will intensify going
forward," Marshall wrote,
"as the company aims to maintain its market share in a declining economic
environment."
From a technological perspective, Apple also faces a cannibalization of the
traditional iPod market by both the iPhone and the iPod Touch, although the
company's executives have suggested that the phenomenon was anticipated.
During a July 21 earnings call, Apple Chief Financial Officer Peter
Oppenheimer said the 7 percent year-over-year decline in iPod sales was due to
"reduced channel inventory" and self-cannibalization
as the touch-screen form factor became more popular with consumers than the
iPod's traditional form factor.
Lastly, the carrier subsidies that Apple earns for the iPhone are, in Marshall's
eyes, unsustainable. "It is estimated that Apple receives approximately
$450 from AT&T Wireless on the activation of an iPhone 3GS as part of a
carrier subsidy program," he wrote. "It is also estimated that Apple
receives an average subsidy of $300 from its international carrier partners as
well."

These subsidies are much higher than those earned by other device makers, such
as Research In Motion, and could be forced to the negotiation table once the
original subsidy agreements expire.
Whether or not Windows 7 turns out to create a revenue drag on its
competitor, Apple predicts revenues of $11.3 billion for the quarter ending in
December.

Nicholas Kolakowski is a staff editor at eWEEK, covering Microsoft and other companies in the enterprise space, as well as evolving technology such as tablet PCs. His work has appeared in The Washington Post, Playboy, WebMD, AARP the Magazine, AutoWeek, Washington City Paper, Trader Monthly, and Private Air. He lives in Brooklyn, New York.